On Buying Silver Because Of The Gold To Silver Ratio

One of the things which usually gives silver (NYSEARCA:SLV) investors hope is that they expect silver to somehow grab a bit of the attention gold (NYSEARCA:GLD) has gathered in the last few years due to the monetary madness.

There are many reasons for this, starting with the fact that until not so long ago, central banks held silver along with gold in their reserves (something which is now all but gone). Also central to this hope, is the historical gold to silver ratio. As we can see below, for much of its history the ratio between gold and silver was much lower than today. Indeed, a ratio of 12:1 is sometimes bandied about as being the very long term average. Now it sits at 55. (Source for chart: wealthcycles.com, chart is updated at the source so might make sense to bookmark it)

(click to enlarge)

With the ratio so far from where it has been historically, hopes are thus high that silver might rally to take the ratio lower.

Production ratio

One of the arguments also made supporting a lower gold/silver ratio is that the relationship between gold and silver yearly production is also significantly lower than the price ratio. Silver sees yearly production of around 23,800 tons, versus gold at 2,700 tons. This gives us a ratio for production of less than 9:1.

Abundance ratio

One could easily use another argument for a higher ratio. Indeed, a ratio close to where gold and silver have recently been trading. This would be a ratio based on the abundance of gold and silver in the Earth's crust. That would be 0.0011 ppm (parts per million) for gold, and 0.07 ppm for silver. And guess what, the ratio between the two is … 63.6.

Finally

Over the course of history gold's value has many times been set administratively. One cannot be certain that the gold/silver price ratio thus transmits much information. At the same time, the prospecting and production of gold seems much more massive than for silver, given both metals' relative rarity. Gold is justifies its own mining whereas silver is usually a sub-product of mining other minerals.

On the other hand, a significant part of gold's demand is speculative/for investment. Silver's demand is dominated by industrial uses. Thus, we'd expect deep changes in the gold/silver ratio to be dictated more by gold's fluctuations in speculative demand than by silver, even though silver is the most volatile metal right now, perhaps due to its also historically high speculative demand as evidenced by the holdings of the SLV ETF (10,650 tons, or nearly 45% of an entire year's production).

Also importantly, one should remember that the ratio can change favorably by gold falling and silver staying the same, or by both metals falling but gold falling faster. Since usually those advocating buying silver due to the ratio are not proposing a paired long-short trade, this cannot be forgotten.

Conclusion

There is little safety in buying silver long just because the historical gold/silver ratio seems favorable for such a trade. Both gold and silver have seen huge speculation over the last few years due to the monetary madness, which greatly increases the risk of betting in any of the two metals (even if the reason to do so - monetary madness itself - seems obvious).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I will read up to several hundred articles per week and, using my market experience and knowledge, choose 1-3 ideas per week (estimated) where I believe valuation and catalysts align themselves in such a way that decent profits are likely. I will also expose my own ideas where I believe they meet the same threshold;
The ideas will include both a small summary of the overall gist of the idea, a rough expected payoff and what could go wrong as well as links to the supporting sources (including my and other people's articles, inside and outside Seeking Alpha - though most should com from Seeking Alpha as it's clearly the best source for such ideas).
I will provide real-time spots of where I decided to buy and sell the positions, along with my continuing opinion on "open" ideas, and comments on new incoming info and how it might affect the initial thesis;
There will be both short-term ideas and mid/long term ideas. Again, it depends on valuation and the underlying catalysts.

We only use your contact details to reply to your request for more information.We do not sell the personal contact data you submit to anyone else.

Thank you for your interest in Seeking Alpha PROWe look forward to contacting you shortly for a conversation.

Thank you for your interest in Seeking Alpha PRO

Our PRO subscription service was created for fund managers, and the cost of the product is
prohibitive for most individual investors.
PRO Alerts is our flagship product for individual investors who want to be faster
and smarter about their stocks. To learn more about it, click here.
If you are an investment professional with over $1M AUM and received this message
in error, click here and you will be contacted shortly.

Thank you for your interest in Seeking Alpha PROWe look forward to contacting you when we have an individual investor product ready!